Rumors of Exchange Offer Gain Traction

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According to a report issued on January 22, 2013, Legg Mason (NYSE: LM) is in the early stages of formulating a sizable exchange offer. The company has been no stranger to such actions: In August of 2009, it completed a major exchange offer that freed up significant amounts of capital and permitted it to survive until the present. However, speculation is rampant that the current offer is a precursor to the announcement of a going-private takeover or merger. In light of the company's announcement of a major asset write-down and widespread doubt that it can streamline its component businesses on its own, this speculation may not be unfounded.

About Legg Mason

Baltimore-based Legg Mason is a diversified asset-management company that offers a range of consumer-focused financial services. In addition to operating a financial advisory service that caters directly to wealthy private individuals, the company issues mutual funds and other managed investment vehicles through intermediary brokerages. Its wealth-management division manages billions of dollars of deposits and maintains sizable stakes in several prominent hedge funds. As part of these wealth management services, Legg Mason operates tax-protected offshore funds and other vehicles that aim to reduce its clients' tax burdens. The company employs about 2,800 people and earned $175.5 million on $2.5 billion in 2012 revenues. It manages nearly $650 billion in assets.

How the Deal Is Structured

Although the exchange offer remains in its formative stages, key details have emerged. First, it is important to note that Legg Mason's pretax charges during the third quarter of 2012 totaled $734 million. The bulk of these charges could be tied to the write-down of various non-performing assets. This is the latest manifestation of the under-performance that has plagued the company in recent years. Relative to its asset-management peers, Legg Mason is now seen as a clear laggard.

Worth about $650 million, the exchange offer involves the possible exchange of a tranche of 2019 senior debt securities. Legg Mason floated the bonds during the middle of 2012 in order to sever its ties to New York-based private equity firm Kohlberg Kravis & Roberts (NYSE: KKR). Placed privately, the bonds were used to finance the final buyback of KKR's financing facilities. The offer is seen as a tacit admission that Legg Mason will be unable or unwilling to pay down these senior debt notes at maturity.

News of the potential offer has boosted Legg Mason's stock. From its pre-announcement closing price of $26.69 per share, the company's stock price rose to $28.08 during the trading session that followed the news. This represents a one-day return of 5.2 percent for current shareholders. Over the past several months, the company has been locked in a slow but steady uptrend. Barring any unforeseen charges or write-downs in the coming quarters, news of the exchange offer should provide strong support for Legg Mason's stock. This support might force potential bidders for the company to lodge higher-priced offers.

Potential for Further Action

For months, Legg Mason has been the target of heated speculation from certain corners of the market. Specifically, the company appears to be a prime takeover or merger target for a larger, healthier entity. At this point, Legg Mason's management team is not indicating that such an event is in the cards. In tandem with the release of the exchange offer, a company spokeswoman even went so far as to issue a statement that disavowed any further action on the part of the company or any outside actor.

Investors do not appear to be convinced. There are several private-equity and asset-management firms that could afford to snap up Legg Mason in its distressed state. Although KKR's decision to sever its ties with the company indicates that it is not willing to pursue a deeper relationship, other firms appear more receptive to the prospect of a deal.

New York-based BlackRock (NYSE: BLK) is perennially mentioned as a potential suitor for distressed asset management firms. With its enormous heft, solid credit, and mountains of cash, BlackRock could absorb Legg Mason relatively easily. While its balance sheet is not quite as strong, smaller rival Blackstone Group might wish to become involved in either the current exchange offer or a future merger. Alternatively, Legg Mason might become the target of a going-private takeover that results in a major windfall for the company's shareholders.

Long-Term Prospects and Outlook

Legg Mason's immediate priority involves finding a new chief executive to replace its outgoing boss. The company's board is conducting an extensive external search and should be ready to announce its choice by the end of the first quarter of 2013. Once the new chief is in place, the company's "way forward" may become more obvious.

The roots of Legg Mason's problems are difficult to trace. The under-performance of several of its prominent funds have resulted in a sharp rise in retail outflows during the past few years. With the rise of lower-cost, lower-margin competitors and a host of different fund types, Legg Mason's gold-plated business model may be in need of an overhaul.

As such, the company's choice for its new chief executive will be instructive. If its board selects a conservative "caretaker" figure, the likelihood of a merger, buyout or partial takeover may increase. Alternatively, the selection of a bold or outspoken executive may hint that the board does not believe that the company's problems are terminal. In the aftermath of the exchange offer, investors would do well to pay attention to this choice and act accordingly.


mthiessen has no position in any stocks mentioned. The Motley Fool recommends BlackRock. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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